Show notes
Slowly, the market seems to be waking up to a major issue that the likes of Michael Burry, Warren Buffett and Terry Smith have been warning about for years.The issue was highlighted in a recent article in The Wall Street Journal entitled Meta Rakes It In, Yet Still Borrows Billions for AI.Stock based compensation is not the villain most investors think it is. Used with discipline it conserves cash and can strengthen long term returns.But the problems start when discipline fades.The danger begins when equity issuance becomes so aggressive that companies are compelled to spend billions buying back stock simply to mask the damage being done.Per share numbers look healthy, but the underlying economics tell a different story.Corporate stewardship becomes less about durable compounding and more about financial engineering.These companies are increasingly being run for the benefit of insiders and at the expense of the extrernal investors. The Wall Street Journal summed it up well:“Meta’s employees and executives captured the bulk of the rewards from last year’s free cash flow."Worse still, as the result of nuances in accounting standards, this corporate behaviour is not reliably reflected in the 10-Q or 10-K financial reports. In fact, the true economic earnings and free cash flow of these business become significantly distorted. Both are often far lower in reality than reported figures imply.If investors never adjust for this properly, it leads to flawed valuation models, investments made at the wrong price and asset bubbles.Most investors don’t adjust for this at all. Most don’t understand how to adjust for it.This is what Michael Burry has been shouting about recently. He sees the market as broken with corporate valuations being streched, supported by structural flows and accounting optics rather than fundamentals. It’s why he chose to return capital to his investors and then withdraw from the market.The dynamic described by the Wall Street Journal runs through some of the largest companies in the market. Not only Meta Platforms (META), but also Alphabet (GOOG)(GOOGL), Microsoft (MSFT), NVIDIA (NVDA), Palantir (PLTR), Tesla (TSLA) and Apple (AAPL). All rely heavily on stock based compensation alongside large buyback programs. These are exceptional businesses. But capital allocation matters and it’s not being done well.Only one of the magnificent-7 appears to do things differently: Amazon (AMZN). It’s approach is refreshingly honest and transparent.In “The Dangerous Game Investors Are Playing”, we dive deep into the numbers, we break down how this works, how it distorts valuations, what adjustments serious investors must make to avoid overpaying, and how to protect yourself before the music stops!This episode features Professor Kevin Koharki who holds a B.Sc. (Accounting), M.B.A. (Finance), and Ph.D. (Accounting). He serves as an Associate Professor at Purdue University, where he lectures on financial statement analysis, he is the founder of CAE Consulting, which advises the C-Suite of Fortune 100 companies and he is a keynote speaker.DISCLAIMER & DISCLOSURE: The author holds a position in Amazon at the date of publication but that may change. The views expressed are those of the author and his guests and may change without notice. The author and his guests have no duty or obligation to update this information. Some content is sourced from third parties believed to be reliable, but accuracy is not guaranteed. Forward-looking statements involve assumptions, risks, and uncertainties, meaning actual outcomes may differ from those envisaged in this analysis. Past performance is not indicative of future results. All investments carry risk, including financial loss. This analysis is for educational purposes only and does not constitute investment advice or recommendations of any kind. Conduct your own research and seek professional advice before investing. Get full access to Rock & Turner Investment Analysis at rockandturner.substack.com/subscribe